Class notes
Lecture 2 (session 4) – Economics of corporate law
- Course
- Institution
- Book
This document contains the notes from the second lecture.
[Show more]
Connected book
Book Title:
Author(s):
- Edition:
- ISBN:
- Edition:
More summaries for
-
Tutorial 7 – Economics of regulation (LAW4006)
-
Lecture 6 – Competition II (LAW4006)
-
Tutorial 6 – Economics of Competition law I
Seller
Follow
robinUM
Reviews received
Content preview
Lecture 2 (session 4) – Economics of corporate lawLimited liability (3)
Limited liability may generate costs to involuntary creditors
o For example because of negative externalities caused by the company (i.e. torts)
One possible remedy: regulation.
Examples include:
o Limit the corporation’s right to engage in risky activities
o Minimum capital requirements
o Ratio equity / liabilities (in practice: often via loan contracts)
o Outside of company law: mandatory financial guarantees (= mandatory insurance)
What about piercing the corporate veil?
o Piercing the corporate veil means looking at behind the creature of the corporation;
who are the shareholders? Are they maybe companies as shareholders? And who are
their shareholders? An in-depth analysis of the true corporate structure.
o The end-goal is to reach the financial assets of the shareholders in order to
compensate victims.
o The system of limited liability will be disregarded.
Piercing the corporate veil
Disregarding limited liability may be efficient when1:
1. Separate incorporation is used in order to limit tort liability to accident victims
o Tort-victims in a situation where the corporation tries to limit its liability in tort.
We see this all the time! Company lawyers have a full time job trying to limit
liability to save money.
Taxi-example (Posner): the taxi-company separately incorporates each individual car. If there
is an accident with a car leading to damage, the victim cannot reach the money of the taxi
company for which the particular driver and car are working. Problematic in case of damage if
it leads to under compensation of victims involuntary creditors of that individual car.
Is this good enough reason to pierce the corporate veil according to Posner? Rather not,
remains last resort. Posner is critical because of the existing alternatives.2 A good way to
compensate involuntary creditors would be mandatory financial guarantees (= mandatory
insurance) for example. This would be an easier solution: company has to insure itself against
losses like this.
A stronger reason to pierce the corporate veil is needed.
2. Separate incorporation misleads creditors
o There is an increase of information costs
Accepted under certain conditions..
Example Posner: bank holding company and subsidiary company real-estate
Subsidiary company presents itself as closer linked to the bank that it in reality is. Therefor
creating the illusion towards the creditors it had more capital than it in reality had.
1
Check these two requirements when to use this mechanism.
2
See previous slide: limited liability (3).
, For example, Rabobank Real-Estate: when you deal with this company you don’t doubt
anything will go wrong, since it is part of the bank. It could still be a misleading of creditors!
o Still this would be overprotection of creditors if we pierce the corporate veil in a
situation like this;
o Creditors have to do their own due diligence research; judge cannot do this for the
creditors;
o It has to be a real misleading: due-diligence research could not tell you otherwise.
Posner attached two conditions to the misrepresentation:
1) Company should be related businesses
Rabobank and real-estate: yes
Rabobank and ice-cream: no
2) Shareholders who’s assets the victim is after, has to be a company as well
Rabobank owns the shares of subsidiary real-estate company: so we are after assets
of a company.
However, it should be a measure of last resort because3:
o Piercing the corporate veil creates an additional risk to shareholders
People and companies will be hesitant to invest.
o Piercing the corporate veil might be an “administrative nightmare”
Practical reason: different shareholders, how to portion the liability? The point in time
is also relevant: an accident happens in the past, as a result of which we know have
tort victims. But which shareholders are we going to hold liable? Those who own the
shares now? Or those who owned it at the time of the accident? And what if there are
different types of shareholders?
NB: thus, Posner is not against piercing the corporate veil. It can even be used for limiting tort
liability. So Posner is not against going after KPMG’s global company if something happens in the
Netherlands. In such situation there might not even be insurance available – but you should always
first check if there is an alternative.
Agency problems (1)
Separation of ownership and control
o Shareholders versus management: conflict of interest?
Remedies (some examples)
o Private arrangements relating managerial compensation to firm performance as
measured by the value of its shares
E.g. giving stock options to the manager.
o Corporate law that reduces transaction costs by implying protective measures in every
corporate charter, such as:
Supervision by independent board of directors
Ratification of important decisions by shareholders
Unimpeded transfer rights of shares4
Rules on insider trading
Etc.
Agency problems (2)
There are two additional agency problems:
o Between controlling shareholders and minority shareholders
o i.e. when a subset of a firm’s owners can control decisions that affect all owners
3
It is a judge-imposed mechanism, and therefor a judge has to take this into account.
4
Allows shareholders to get rid of their shares when they are not happy with the behavior of the managers. The most important thing is:
shareholders can (en mass) threaten to get rid of their shares and put pressure on the management.
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller robinUM. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $7.05. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
75632 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy study notes for 14 years now